Risk of stock decreases with correct information

A recent FoxNews.com column titled “Are stocks a sucker’s bet?” caught my attention. My guess was that it was simply another one of those columns with a provocative title designed to get our attention.

I didn’t expect any groundbreaking insights, but thought perhaps it was authored by some guru predicting a stock market meltdown ahead.

I then noticed it was written by Peter Morici, an economist who I have been seeing more and more as a talking head on cable television financial shows and who is a paid spokesperson in some consumer product advertising.

As I read through the article, I quickly lost track of the number of statements Morici made about stocks and investing which were simply wrong. So, why I am wasting your time discussing the piece? Many of Morici’s arguments are increasingly making their way into the polluted and erroneous thinking of the mainstream media.

Below are the highlights of Morici’s points, followed by my analysis:

<i>The individual investor left the stock market due to the 2008 financial crisis.</i> This is completely false. But, many journalists and folks who write about investing and the financial markets without doing their homework assume that individual investors are clueless and run from stocks and never come back during a major slide. The facts show otherwise.

<i>During the past two business cycles, stock prices have not followed corporate profits higher.</i> This is completely false and inaccurate as well. During the early 2000s and late 2000s recessions, corporate profits dropped sharply, as did stock prices. In the aftermath of those declines, corporate profits and stock prices rebounded smartly.

<i>While corporate profits are up 135 percent since 2000, stock prices (S&P 500) are at the same level as they were back in 2000.</i> It is mostly true that, as measured by the S&P 500 stock index (which tracks large company U.S. stocks), stock prices are now about where they were back in 2000 yet corporate profits are quite a bit higher (although about 85 percent higher, not 135 percent). Morici failed to note that stock investors have earned dividends which aren’t reflected in the level of an index like the S&P 500. Also, smaller and mid-size U.S. company stock indexes have hit new all-time highs as have a number of overseas indexes including those tracking emerging markets.

<i>Stocks are flat despite much higher corporate profits since 2000 because, “the increased value created by higher profits has been captured by hedge funds, electronic traders, private equity funds, aggressive M&A shops and trading desks at investment banks.”</i> This is utter nonsense. The price-earnings ratio (which measures the multiple of profits investors are willing to pay for stocks) on the S&P 500 in 2000 was a historically plump 27 — almost double the historic average. The price-earnings ratio today is about 14 — almost exactly the historic average.

<i>Through superior information, quick execution and aggressive marketing, traders and dealmakers capture a great deal of the potential increase in value created by new and anticipated corporate profits before that value is recognized in stock prices.</i> Hedge funds, electronic traders, private equity firms, etc. have been around since well before 2000. In the case of hedge funds, there’s not even proof they outperform the market averages over the long-term because of their bloated fees. Electronic traders may make the markets more efficient, but don’t drain away all the profits!

<i>The individual investor does not have the resources to compete with these pros.</i> The fact of the matter is that individual investors have more options open to them than ever before to invest their money with leading investment professionals. And, folks can use index funds and do fine. Or they can choose their own stocks with far more resources and information at their fingertips than in years past.

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